Digest: Prior to conclusion of a pending matter, a lawyer may agree with a client to modify an engagement agreement with the client to provide, as security for legal fees and expenses already due and owing in a a fixed amount on which the parties agree, for the exception and filing of a confession of judgment, and the execution and recording of a collateral mortgage with a security interest, if the lawyer complies with rules governing business transactions with a client and thereafter abides by the general rules governing conflicts.

1. The inquiring law firm represents two individuals and a
company as defendants in a pending and hotly contested dissolution proceeding;
the two individuals are principals of the client company, as to which the Court
has appointed a Receiver. The law firm
is owed a substantial amount in attorneys’ fees and expenses incurred over more
than a year in defense of the inquirer’s clients. The Receiver holds funds consisting of, among
other things, the proceeds from the sale of real property previously owned by
one of the inquirer’s clients. With the
clients’ joint consent, the firm has asked the Receiver and the Court to permit
the Receiver to release funds to pay the inquirer’s outstanding fees and
expenses. The adverse party objects to
the release of receivership funds for this purpose, and to date the firm
remains unpaid.

2. The inquirer does not wish to abandon the clients, but is
concerned that, in light of the likely expenses of the receivership, as well as
creditors with potential claims with priority over any claim for defense fees
and costs, there may be insufficient funds remaining to pay the inquirer’s
outstanding invoices. The firm
recognizes that the clients are in a financially parlous condition, struggling
to make ends meet, which is among the reasons why the inquirer does not want to
impose the economic burden that the firm’s withdrawal from the representation
would impose on them. Having discussed
the matter with the clients, the inquirer proposes to have each client execute,
and to have the inquirer file or record as the case may be, client affidavits
confessing judgment and a collateral mortgage with a security interest, in each
instance limited to the fixed amount, on which the parties agree, currently due
and owing to the law firm for services already performed.

3. The inquirer intends to notify the Receiver of these
transactions, and anticipates that the Receiver will notify the Court and the
adverse party. The law firm’s engagement
letter with the clients makes no provision for these security arrangements.

QUESTION

4. May a law firm agree with its clients to amend its existing
engagement letter with the clients during the pendency of a matter to provide
for the clients to execute, and for the law firm to file or record, affidavits
confessing judgment and collateral mortgages as security for accrued but unpaid
attorneys’ fees and expenses in a fixed amount on which the parties agree?

OPINION

5. Our role is to interpret the New York Rules of Professional
Conduct (the “Rules”), not to opine on issues of law, including laws addressing
creditor rights. Accordingly, for our
purposes, we assume without deciding that the proposed security arrangements,
as well as the contemplated notice of them, do not violate any statute or rule
governing Court-supervised receiverships, including the rights of any third
parties or arrangements between the inquiring firm and clients subject to the
receivership. We note, too, that nothing
in this opinion is intended to apply to
fee arrangements in a domestic relations matter, in which special rules
control. Rule 1.5(d)(5)(iii) (a lawyer
may not enter into an arrangement for any fee in a domestic relations matter
that “includes a security interest, confession of judgment or other lien
without,” among other things, “approval from a tribunal after notice to the
adversary”); see N.Y. State 1134
(2017) (whether a lawyer in a domestic relations matter may use a credit card
to secure legal fees is a question of law under 22 N.Y.C.R.R. Part 1400).

6. In N.Y. State 910 ¶ 19 (2012), this Committee said that
“[r]etainer agreements, like all contracts, may be amended with the agreement
of the lawyer and the client.” We
cautioned, however, that “such an amendment raises ethical concerns, because
[the] lawyer is often in a position to take unfair advantage of the client.” There, as here, the inquirer sought to amend an
existing retainer agreement to provide for, among other things, arrangements
(including a confession of judgment) to secure payment of the lawyer’s fees and
expenses. We noted there that, though
certain amendments could be considered “normal fee negotiations” subject only
to the regulations of Rule 1.5, which govern all fee agreements, “others are
considered a ‘business transaction with a client’” that are subject to the
“higher scrutiny of Rule 1.8.” We
identified a number of factors that determine whether a particular amendment
warranted this heightened level of review.
Id. ¶¶ 20-24; see N.Y. State 1051 ¶ 16 (2015)
(applying factors to conclude that Rule 1.8(a) applies to a change in a
contingency fee agreement enabling the lawyer to be paid out of the proceeds of
a third-party loan made as an advance against the client’s later recovery in a
structured settlement).

7. The considerations germane to assessing the applicability of
Rule 1.8(a) – among them, the timing and circumstances of the proposal, the
sophistication of the client, the beneficiary of the amendment (lawyer or
client), whether the client has deliberately disregarded an obligation to pay –
are fact-intensive, but we need not resolve them, for the requirements of Rule
1.8(a) would apply to the inquirer’s proposed security arrangements even if
part of the original retainer agreement.
Comment [16] on Rule 1.8 says as much:
“When a lawyer acquires by contract a security interest in property
other than that recovered through the lawyer’s efforts in the litigation, such
an acquisition is a business or financial transaction with a client and is
governed by the requirements of paragraph (a).”
See Cmt. [4C] (Rule 1.8(a)
applies “when a lawyer accepts an interest in the client’s business or other
nonmonetary property as payment of all or part of the lawyer’s fee”); N.Y.
State 1104 (2016) (initial engagement letter securing legal fee with a
promissory note is subject to Rule 1.8(a)); ABA 11-458 (2011) (amendment to fee
arrangements that involve a lawyer acquiring an interest in client property is
subject to Model Rule 1.8(a)). Thus,
even if some of the factors outlined in N.Y. State 910 might justify an
amendment here with reference only to Rule 1.5, the proposed security
arrangements require adherence to Rule 1.8(a).

8. Rule 1.8(a) provides:

A
lawyer shall not enter into a business transaction with a client if they have

differing
interests therein and if the client expects the lawyer to exercise professional
judgment therein for the protection of the client, unless:

(1) the
transaction is fair and reasonable to the client and the terms of the
transaction are fully disclosed and transmitted in writing in a manner that can
be reasonably understood by that client;

(2) the
client is advised in writing of the desirability of seeking, and is given a
reasonable opportunity to seek the advice of independent legal counsel on the
transaction; and

(3) the
client gives informed consent, in a writing signed by the client, to the
essential terms of the transaction and the lawyer’s role in the transaction,
including whether the lawyer is representing the client in the transaction.

9. Here, the interests of the inquirer and the clients are
“differing” within the meaning of Rule 1.0(f), which defines “differing
interests” as “every interest that will adversely affect either the judgment or
the loyalty of a lawyer to the client, whether it be conflicting, inconsistent,
diverse, or other interest.” However much the parties may now view the
arrangement as a means to maintain their attorney-client relationship, the
entry of confessions of judgment and the recording of mortgages with a security interest places the
lawyer in direct adversity to the clients.
Similarly, while a client may not reasonably expect a lawyer to exercise
professional judgment on the client’s behalf in the negotiation of a routine
retainer agreement, circumstances may exist in which such an expectation arises
depending on the sophistication of the client, the complexity of the arrangement,
whether the matter is ongoing, and whether the client has independent counsel
to assess the transaction. See N.Y. State 1104 ¶ 5. That here the law firm is proposing a
somewhat elaborate amendment to the parties’ agreement amid an ongoing
representation of otherwise unrepresented clients in a hotly contested
litigation is likely to create a reasonable expectation that the law firm is
exercising its professional judgment on the clients’ behalf. See N.Y.
State 1055 n. 1 (2015) (client expectation likely when, for example, client has
no other counsel, and the lawyer is acting for the client in the matter); N.Y.
State 913 ¶ 7 (2012) (client likely to rely on lawyer when lawyer is
receiving equity in client’s company as a fee).

10. Rule 1.8(a)(1) requires that the terms of the transaction be
fair and reasonable to the clients. The fairness and reasonableness of the
proposed arrangement depends primarily on “the circumstances reasonably
ascertainable at the time of the transaction.”
N.Y. State 913 ¶ 12. This turns
on facts and circumstances beyond our ability to evaluate based on the
inquiry. For now, we note only that, as
we said in N.Y. State 477 (1977), the amount of the confession of judgment (and
by necessary implication, the amount of the mortgage) must be “commensurate
with the value of the services rendered,” which means that the fee may not be
excessive in violation of Rule 1.5(a), and that the lawyer must “scrupulously
observe the provisions” of ethical rules “bearing upon legal fees,” including obtaining
the clients’ agreement to the amount. In addition, here, the inquirer intends
to limit the amount of the security interest, whether by a confession of
judgment or a collateral mortgage with a security interest, to the amount of
fees and expenses currently due and owing for services already performed. We therefore need not address whether Rule
1.8(a) would permit the parties agree to agree on an amount higher than the
accrued but unpaid invoices. Compare N.Y. State 910 ¶ 12 (“a
confession of judgment to secure attorneys fees may be taken only as a form of
security and not of payment, and that it may be taken only to secure payment
for services previously rendered”) with ABA
02-427 (2002) (not per se improper
for a lawyer to take a security interest for the payment of fees “earned or to
be earned”).

11. Rule 1.8(a)(1) requires, too, that the law firm completely and
lucidly explain the transaction in writing to the clients in language that the
clients may reasonably grasp. This
requirement is entwined with the requirements of Rule 1.8(a)(3), which says in
part that the clients must give their “informed consent, in a writing signed by
the client, to the essential terms of the transaction.” Rule 1.0(j) defines “informed consent” as an
“agreement by a person to a proposed course of conduct after the lawyer has
communicated information adequate for the person to make an informed decision,
and after the lawyer has adequately explained to the person the material risks
of the proposed course of conduct and reasonably available alternatives.” The “requirements for client consent to
conflicts under [Rule] 1.8(a) are at least as stringent as those under Rule
1.7(b),” the rule on general conflicts.
N.Y. State 1055 ¶ 8.

12. In Opinion 910, we approved a lawyer
obtaining a confession of judgment provided that, among other things, “the
client clearly understands the character, effect and purpose of the confession
of judgment. This includes the potential
effect of a confession of judgment on the client’s credit standing and
employment opportunities.”
Publicly-docketed confessions of judgment, and a UCC-recorded mortgage
with security interest, are potent creditor tools that may have a substantial
harmful impact on the client-debtors, among them an injurious effect on banking
accounts, the ability to obtain or maintain credit lines, and to sustain
business operations. Without attempting
an exhaustive list of information that may be “adequate” in these
circumstances, components of the information to be relayed may include: (a) whether the firm intends to seek entry of
a judgment based on the client affidavits confessing judgment; (b) whether and
to what extent the entry of a judgment starts the accrual of statutory post-judgment
interest; (c) whether the clients’ affidavits effect a waiver of their right,
if any, to arbitration of fee disputes as set forth in Rule 1.5(f) and 22
N.Y.C.R.R. Part 137 et seq., a
question of law on which we do not opine; and (d) whether a reasonable
alternative exists to address the law firm’s unpaid invoices – for instance,
holding but not filing the security documents.
Our concern is that the clients be fully advised of all the material
consequences of the proposed course of conduct and any reasonably viable
alternative to enable the client to make an informed choice.

13. We are mindful of the opposing interests
at stake. Inhering in the concept of
informed consent is freedom of choice, that is, circumstances that are not so
coercive as to negate any meaningful election.
Here, the clients’ difficult financial position may leave them no option
but to accede to the law firm’s request if the only alternative is the law
firm’s withdrawal from representing them in the pending matter. Yet a law firm has a right to be paid for
services rendered in accordance with the parties’ agreement. Rule 1.16(c)(5) permits a law firm to
withdraw from a representation when a client “deliberately disregards an
agreement or obligation to the lawyer as to expenses or fees,” albeit here,
under Rule 1.16(d), only with permission of the Court if the rules of the Court
so mandate. In our view, if a law firm
has a right to withdraw from a representation consistent with Rule
1.16(c)(5) – the inquirer so assumes and
we proceed on that assumption – then a proposed amendment to a retainer
agreement securing the clients’ existing obligations to the law firm does not
create circumstances in which informed consent is beyond the contemplation of
Rule 1.8(a).

14. The balance of Rule 1.8(a) reinforces the
import of the provision for informed consent.
Rule 1.8(a)(3) prescribes that, in the same writing setting forth the
essential terms of the transaction, the lawyer must also describe the lawyer’s
role in the transaction, including whether the lawyer is representing the
client in the transaction. See N.Y. State 958 ¶ 12 (2013) (lawyer’s
charging of a finder’s fee must be fully set forth in writing to the client
compliant with Rule 1.8(a)). Here, the
lawyer’s role is the preparation of the security documents, and the law firm
appears poised to act for the client in effecting those transactions. The transactions are for the benefit of the
law firm, no matter that the clients may wish the law firm to refrain from
withdrawal. This fact enhances the
significance of Rule 1.8(a)(2), which obligates the law firm to advise the
clients, in writing, of the desirability of seeking, and giving the clients a
reasonable chance to obtain, independent counsel to advise them on the proposed
security arrangements. Although Rule
1.8(a)(2) does not require the clients actually to retain separate
disinterested counsel, case law exists to suggest that the absence of one may
facilitate challenges to business transactions with clients. See,
e.g.¸ McMahon v. Eke-Nweke, 503
F. Supp. 2d 598, 604 (E.D.N.Y. 2007) (analysis under predecessor of Rule
1.8(a)).

15. The focus of the inquiry, and hence this opinion, is on
the inquirer’s ethical duties in obtaining the proposed amendment to the
parties’ existing engagement agreement.
Nevertheless, one further consideration merits mention. If the parties agree to the proposed
amendment consistent with Rule 1.8(a), the inquirer, in continuing to represent
the clients, is still bound by Rule 1.7 governing general conflicts of
interest. Rule 1.7(a)(2) provides that a
lawyer shall not represent a client, except as permitted by Rule 1.7(b), if
"there is a significant risk that the lawyer's professional judgment on
behalf of a client will be adversely affected by the lawyer's own financial,
business, property or other personal interests." Thus, the inquirer should consider whether
the firm’s security interests affect the firm’s ongoing representation of the
clients in the dissolution proceeding.
It is possible, for instance, that in some circumstances either delay or
expedition of the proceedings could enhance the value of the inquirer’s
security interests. See N.Y. City
2000-3 (2000) ("An attorney's inquiry into her potential ethical
obligations arising out of a transaction in which the attorney accepts securities
for fees does not end with [the rule on business transactions with clients]).
Unique issues of potential conflicts of interest also may arise as a result of
such arrangements."); see also Rule 1.8 Cmt. [4D] ("An
exchange of securities for legal services will also trigger the requirements of
Rule 1.7 if the lawyer's ownership interest in the client would, or reasonably
may, affect the lawyer's exercise of professional judgment on behalf of the
client").

CONCLUSION

16. A law firm may seek its clients’ agreement to modify its
retainer agreement with the clients during the pendency of a current matter to
secure payment, by confessions of judgment and collateral mortgages, of fully
earned but unpaid legal fees and expenses in an amount on which the parties
agree, if the law firm complies with the rules governing business transactions
with clients and is mindful of ongoing obligations to avoid general conflicts
of interest.